Published on
The Guardian/UK

Powerless on Oil Prices

With oil prices soaring to $109 a barrel in an election year, the White House is getting jittery. President Bush is despatching vice-president Dick Cheney to Riyadh on Sunday to urge King Abdullah to raise the kingdom's oil output to reverse the price rise.The chances of Cheney's success are slim: at Opec's quarterly meeting in Vienna last week, where Saudi Arabia is a leading player, the organisation decided against raising production.

In any case, the Bush administration's plea is based on assumptions that are invalid or outdated.

The size of oil supplies is just one factor among others that determine its market price.

An equally important factor is the capacity of refineries to transform crude oil into different end-products, with each refinery designed to process petroleum of certain density, which varies from 15 to 45 degrees, the higher figure signifying lightness.

Mismatch between the available crude oil and the type of refinery leads to bottlenecks, not to mention the total capacity of refineries falling behind the aggregate amount of crude available worldwide. There is nothing that Opec members can do about this.

Following the oil price explosion in 1973-74 - caused by the Arabs reducing their petroleum shipments to the west during and after the October 1973 Arab-Israeli war - Opec acquired the power to set prices and make them stick. But this did not last.

The mid-1970s petroleum price hike made the global economy more volatile than before. The gradual deregulation of the economy in the western nations accelerated when Ronald Reagan became US president in 1981. As a result, futures contracts arose for currencies and gold, with the New York Mercantile Exchange (Nymex) emerging as the leader. In 1981 it added petrol to its list of traded commodities.

In March 1982, due to the continued low oil output in the warring Iraq and Iran, non-Opec production outpaced Opec's. Much of the non-Opec's new petroleum came from the North Sea and was sold on Rotterdam's spot market, where the price was determined by a variety of market factors.

This made it hard for Opec to maintain its reference price of $34 a barrel. In early March 1983, yielding to market forces, it slashed the price for the first time by 15% and reduced output.

On March 30, 1983, Opec's power to determine oil price received a fatal blow. That day Nymex introduced futures in petroleum. That meant the oil price being fixed daily, determined by the give-and-take of Nymex traders, with buyers and sellers monitoring their computer screens worldwide.

A futures contract is a promise to deliver a given quantity of a standardised commodity at a specified place, price and time in the future. It is a derivative, not the real thing. There are thousands of oil transactions daily, but few of these shipments are delivered. Instead, they are constantly re-traded, based on the market price of the moment. That is, the rights to a single barrel of oil are bought and sold many times over, with the profits or losses going to the traders and speculators.

Given the current weakness in the equity markets, the falling value of the dollar, and the credit crunch caused by the sub-prime mortgage crisis in the US, speculators are putting their funds into such safe havens as gold and oil, spiking up their prices.

There is nothing that the Saudi monarch or the rulers of other Opec member states can do to reverse this situation.

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